Business Context and Reporting Period
Trex Company, Inc. manufactures and markets wood-alternative decking, railing, fencing, trim, framing and outdoor lighting products under the Trex brand. The company operates in one business segment and manufactures products exclusively in the United States. This Form 10-Q covers the quarter and nine months ended September 30, 2015, compared with the corresponding 2014 periods.
Key Financial Metrics
| Metric | Three Months Ended September 30, 2015 | Three Months Ended September 30, 2014 | Nine Months Ended September 30, 2015 | Nine Months Ended September 30, 2014 |
|---|---|---|---|---|
| Net sales | $94.0 million | $95.5 million | $351.6 million | $317.5 million |
| Gross profit | $22.1 million | $30.4 million | $122.9 million | $113.6 million |
| Gross margin | 23.6% | 31.8% | 35.0% | 35.8% |
| Income from operations | $6.4 million | $14.5 million | $64.2 million | $59.1 million |
| Net income | $3.7 million | $8.9 million | $40.0 million | $36.4 million |
| Diluted earnings per share | $0.12 | $0.28 | $1.25 | $1.10 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $12.2 million | $45.3 million |
- Third-quarter operating margin was approximately 6.9%, compared with approximately 15.1% in the prior-year quarter. Nine-month operating margin was approximately 18.2%, compared with approximately 18.6% in 2014.
- Third-quarter selling, general and administrative expense was $15.7 million, or 16.7% of sales. Nine-month expense was $58.8 million, or 16.7% of sales, versus 17.2% in 2014.
- Cash and cash equivalents were $2.5 million at September 30, 2015, compared with $9.5 million at December 31, 2014.
- Accounts receivable increased to $80.4 million from $36.4 million at year-end 2014, primarily reflecting the timing of customer payments and the seasonal early-buy program.
- Inventory declined to $17.0 million from $23.7 million at December 31, 2014.
- Capital expenditures were $18.3 million for the first nine months, compared with $8.8 million in 2014. Management estimated full-year 2015 capital expenditures of approximately $25 million.
- Outstanding revolving-credit borrowings were $48.5 million, with approximately $51.5 million of remaining borrowing capacity. The stated interest rate was 1.4%, and the company was in compliance with its debt covenants.
Material Changes Versus the Prior Comparable Period
- Nine-month sales increased 10.8%, driven by an 8.0% increase in volume and a 2.5% increase in average price per unit. Management attributed volume growth to market-share gains and increased demand for wood-alternative products; pricing benefited from product price increases and a mix shift toward higher-priced products.
- Third-quarter sales decreased 1.5%, reflecting a 1.0% volume decline and a 0.5% decrease in average price per unit. Management attributed the volume comparison partly to elevated 2014 sales resulting from weather-related extension of the decking season.
- Third-quarter gross margin fell 8.2 percentage points, primarily because of a $7.0 million warranty-reserve adjustment. Excluding that adjustment, management stated that gross margin declined modestly to 31.0%.
- Nine-month gross margin declined 0.8 percentage points. The decline reflected a $7.8 million increase in the warranty reserve, partially offset by a 1.4% benefit from higher-margin product mix.
- Nine-month net income increased 10.0%, while diluted EPS increased to $1.25 from $1.10, helped by a lower diluted share count.
- Operating cash flow declined $33.2 million, principally because accounts receivable consumed $44.0 million of cash versus $7.7 million in the prior-year period. Management expected to collect the outstanding receivables during the fourth quarter.
- Net cash used in investing increased because of higher capital expenditures. Financing cash use declined because of higher net borrowings and lower excess tax benefits from stock compensation.
- The company repurchased 1,134,300 shares for $45.2 million during the quarter under its prior repurchase program. On October 22, 2015, that program was terminated and replaced with authorization to repurchase up to 3.15 million shares through December 31, 2016; no shares had been purchased under the new program as of October 27, 2015.
Guidance, Outlook, Risks and Unusual Items
- Management expected cash on hand, operating cash flow and available revolver capacity to fund planned capital expenditures, warranty payments, debt service and other requirements. The filing does not provide a formal sales or earnings forecast.
- The business is seasonal, with historically lower fourth-quarter sales because of holidays and adverse weather. Early-buy incentives can materially affect sales, receivables and inventory levels.
- The company recorded a $5.4 million third-quarter increase to the surface-flaking warranty reserve after claims received and average settlement costs exceeded expectations. The total surface-flaking reserve was $31.6 million at September 30, 2015, and the filing states that a 10% change in expected remaining claims or settlement costs could change the reserve by approximately $3.2 million.
- Product warranty liabilities relate principally to surface-flaking claims involving material produced at the Nevada facility before 2007. Actual future claims, settlement costs and cash payments could differ materially from estimates.
- The company maintained a $2.5 million liability for expected shortfalls on a former headquarters lease. Future charges could increase if sublease renewals, occupancy timing or rental rates differ from assumptions.
- Key operating risks include market acceptance of products, economic and weather conditions, raw-material availability and costs, transportation costs, product quality, warranty and consumer-relations expenses, competitive pressures and potential distribution-channel inventory buildup.
- The company was assessing the impact of the new revenue-recognition standard, effective for the company after December 15, 2017, and had not selected an adoption method. It did not expect the debt-issuance-cost standard to have a material impact.
- Routine lawsuits and claims were pending, but management believed their ultimate resolution would not materially affect financial condition, results, liquidity or competitive position.
Important Facts for Investors to Verify
- Whether fourth-quarter collections of the elevated accounts-receivable balance occur as expected and support repayment of seasonal revolver borrowings.
- Whether surface-flaking claims continue to decline and whether the $31.6 million warranty reserve is sufficient, given the sensitivity of the estimate to claim volume and settlement costs.
- Whether the sharp third-quarter margin decline was isolated to the warranty adjustment or signals broader product-mix, pricing or manufacturing pressure.
- Actual full-year capital expenditures compared with management’s approximately $25 million estimate and the resulting effect on liquidity.
- Fourth-quarter demand, distributor inventory levels and weather-related seasonality.
- Future share repurchases and their effect on leverage, liquidity and per-share results.
- Compliance with revolving-credit covenants and the availability of approximately $51.5 million of unused borrowing capacity.